When pension simplification came into effect on 6 April 2006 (A-day), it introduced the concept of the lifetime allowance (LTA).
The LTA was originally set at £1.5m, but this may have been less than the benefits already accrued by some at A-day or their planned retirement date. In order not to disadvantage these people, the government introduced transitional protections that gave a higher or unlimited entitlement to the LTA.
When the LTA began to drop in 2012, further protections were introduced. These protections came with rules that, if broken, make protection invalid. In this case, the client will need to inform HM Revenue & Customs and then revert to the standard LTA or, if applicable, another dormant LTA protection they may also hold. We are now in the position where the standard LTA isn’t applicable for many, and where they are restricted on what they can and can’t do in order to protect themselves from unnecessary LTA charges.
Unfortunately, not all protections have the same rules, and even those that appear similar contain differences that can have a significant effect.
Primary protection
Primary protection helped to protect pension benefits valued in excess of £1.5m at A-day. It was only available to those individuals who had benefits over this level. Individuals were entitled to remain as a member of a pension scheme and to continue to contribute or accrue benefits.
Primary protection can only be lost when there has been a pension debit that, when taken from the original protected amount, brings the fund at 6 April 2006 below £1.5m. The debit figure isn’t adjusted for the time between 2006 and the date of the pension debit. As we get further from 2006, this means it is increasingly likely that the primary protection will be lost.
For example: Joan had pension benefits worth £3m at A-day, giving her a primary protection factor of one (one extra LTA). In 2017 her benefits had grown to £5m and when she divorced, her husband was awarded a 50 per cent pension sharing order worth £2.5m.
Joan loses her primary protection because when the £2.5m is taken from the original protected amount of £3m, it only leaves £500,000.
Enhanced protection
It is possible to lose enhanced protection (EP) if any of the following occur after 6 April 2006:
• Relevant benefit accrual under a registered pension scheme;
• Impermissible transfer from an arrangement;
• A transfer of sums and assets that is not a permitted transfer;
• A new arrangement is opened other than in permitted circumstances;
• The member notifies HMRC that they no longer wish to be covered by enhanced protection.
Relevant benefit accrual under a money purchase pension scheme is simple: it is anything that is paid into the scheme as a relievable pension contribution. This includes any employer contributions and in some circumstances will include the payment of compensation into the pension scheme. Care needs to be taken when receiving compensation for any pension issues.
Relevant benefit accrual under a defined benefit (DB) scheme is only tested at the point that the member takes benefits or makes a permitted transfer to a money purchase pension scheme. At this point in time the capital value of the benefits, called the relevant crystallised amount (BCE amount or CETV if a transfer), is tested against the appropriate limit. If the relevant crystallised amount is more than the appropriate limit, EP will be lost.
The appropriate limit can be calculated in two ways, and whichever calculation gives the highest amount can be used.
The earnings recalculation amount can be used if the individual is still a member of the scheme and it uses the benefits accrued at 6 April 2006, but with the relevant salary applicable at the date of the test. This salary may be subject to an earnings cap if applicable to the scheme. The increase in benefits then needs to be capitalised to give the appropriate limit.
Alternatively, the indexed amount can be used. The capital value of the pension at 6 April 2006 is indexed by the higher of 5 per cent compound, retail price index inflation or statutory increases to give the appropriate limit.
If relevant benefit accrual hasn’t occurred, generally a transfer of any registered pension scheme to a money purchase pension scheme will not invalidate EP. Transfers between DB schemes will mean the loss of EP except in a few select circumstances such as a scheme wind-up, the sale of one company to another or a retirement benefit compliance exercise.
Individual protection (2014 and 2016)
Individual protection (IP) can only be reduced or lost where the value of the individual’s benefits at the valuation date is reduced because of a pension debit.
Calculating the reduction in relation to the IP, the value of the sharing order is reduced by 5 per cent for each full tax year that has elapsed between the valuation date and the date of the sharing order. This figure is then taken from the original IP valuation (even if this valuation was in excess of the actual protection available), and if the resulting amount is less than £1.25m for IP14 or £1m for IP16 the protection is lost. If the amount isn’t below these levels then the IP14 or IP16 personalised LTA is amended accordingly.
IP is not lost in other circumstances. In particular, where an individual’s pension benefits are reduced to take account of a ‘scheme pays’ liability (where the individual’s scheme has paid all or part of his/her annual allowance tax charge), this is not deemed to reduce the value of the individual’s pension savings at the valuation date for IP purposes.
Fixed protection (2012, 2014 and 2016)
It is possible to lose fixed protection (FP) of any variety if any of the following occur after the application date:
• Benefit accrual under a registered pension scheme;
• An impermissible transfer from their arrangement;
• A transfer of sums and assets that is not a permitted transfer; or
• A new arrangement is opened other than in permitted circumstances.
As mentioned with regards to EP, benefit accrual under a money purchase pension scheme is simply anything paid into the scheme as a relievable pension contribution, including any employer contributions and in some circumstances the payment of compensation into the pension scheme.
As previously highlighted, care needs to be taken when receiving compensation for any pensions issues. In many cases, the company or person paying the compensation will want to reduce the payment by basic-rate tax and pay it to the scheme. This should be avoided as it will invalidate FP.
Accrual in a DB scheme could in theory continue, provided it doesn’t exceed the relevant percentage, which is the consumer price index (CPI) as of the previous September. In practice, continued active membership will eventually lead to invalidating protection because the increase in benefits is likely to exceed the relevant percentage. It should be noted that CPI was zero in the tax year 2015-16, so any active members would have invalidated their protection then. One important difference with regards to FP is that the test is a rolling one and doesn’t just occur when benefits are taken or when there is a transfer. This means it could happen at any time.
A transfer of a registered pension scheme to a money purchase pension scheme will not invalidate FP. However, if a transfer is from a DB scheme to a money purchase scheme the amount transferred needs to be actuarially equivalent. This means that if the transferring scheme offers an enhanced transfer value, FP will be lost. Transfers between DB schemes will mean the loss of FP bar a handful of situations, for example, a retirement benefit compliance exercise, a scheme wind-up, or the sale of one company to another.
Opening a new arrangement to receive a permitted transfer as part of a retirement-benefit activities compliance exercise, or as part of an age equality compliance exercise, will not result in the loss of FP, but if a new arrangement is opened for any other reason FP will be invalidated.
Claire Trott is head of pensions strategy at Technical Connection
